The limited liability company has become a popular choice for small businesses because it offers a simple business structure, flexible tax options, and protection for its owners' personal assets from being claimed to pay off a company’s debts and obligations. An LLC brings a level of formality above a sole proprietorship or general partnership, but avoids the complicated paperwork of a corporation.
Regulated by States
LLCs are governed under state statute, and details of regulations, filing requirements and fees can vary from state to state. Generally, an LLC is formed when it file articles of organization, certificates of formation or similarly titled document with the secretary of state’s office in the state in which the company is being organized. Filing fees charged by the states can range from $70 to $500. The Texas fee for filing a certificate of formation is $300. Unlike a corporation, there is no requirement for an LLC to conduct annual meetings and file the meeting minutes with the state.
Owners of an LLC are called members, and there is no upper limit on the number of members. The number of members for an LLC can also be as low as one. Initially, states did not allow single-member LLCs when authorizing statutes were first passed in the 1980s and 1990s, but they’re now allowed in every state. Members can be individuals, partnerships, corporations, foreign entities and other LLCs. Some types of businesses, such as banks and insurance companies, are barred from forming as LLCs.
Read More: Can a Minor Own a Membership in an LLC?
The Internal Revenue Service does not recognize an LLC for federal tax purposes. By default, the IRS will generally tax a single-member LLC as a sole proprietorship, and a multimember LLC as a partnership. But LLCs can elect to be taxed as a C or S corporation by filing IRS Form 8832 and indicating its choice. LLCs can elect a choice as an “initial classification” immediately when the company is formed. When an LLC elects to change its tax status, and the election was not an initial classification, the LLC must wait five years before electing to change its classification again.
LLC members can decide how to distribute profit among themselves. Unlike a corporation, where each shareholder’s dividend is dependent on the amount of his or her investment, members can agree to give a managing member a disproportionate amount to compensate for running the business. But an LLC member taxed as a sole proprietorship or partnership cannot be paid a wage. Instead, shares of profit distributed to any member active in the business of the LLC will be subject to self-employment tax. All shares of profit and loss are passed through to be reported on each member’s tax return. The company itself is not taxed as would happen with a corporation.
Changing Tax Status
As an LLC’s profits rise, the tax advantage can switch from an LLC’s default classification. An LLC can choose to be taxed as an S Corporation, a designation under the federal tax code, which allows a managing member to be paid a reasonable salary by industry standards. The salary is subject to employment taxes and withholdings. But any distribution of profit made to a managing member beyond the salary are not subject to employment taxes.
Tom Chmielewski is a longtime journalist with experience in newspapers, magazines, books, e-books and the Internet. With his company TEC Publishing, he has published magazines and an award-winning multimedia e-book, "Celebration at the Sarayi." Chmielewski's design skills include expertise in Adobe Creative Suite's InDesign and Photoshop. He holds a Bachelor of Arts in English from Western Michigan University.